Dollar: Nothing Positive from the Fed

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Daily FX Market Roundup / Asia Preview 06-20-12

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management

USD: Nothing Positive from the Fed
EUR: Thursday is a Big Day for Europe
GBP: QE Coming in July
CAD: Looking for Increase in Retail Sales
AUD: Chinese PMI Numbers on Tap
NZD: Narrow Current Account Deficit
JPY: Trade Deficit Continues to Grow

USD: Nothing Positive from the Fed

The market’s reaction to the Federal Reserve’s monetary policy decision was fascinating. Nothing that the Federal Reserve said or did was positive for the dollar and yet the greenback rallied after the release of the FOMC statement and throughout Bernanke’s press conference. In between, the dollar reversed course, leading to significantly intraday volatility but eventually by the end of the North American trading session, the dollar was lower against euro. This rollercoaster price action tells us that investors expected more from the Federal Reserve even though they over delivered by growing more dovish. Unlike earlier this month, Bernanke did not downplay the weakness in the U.S. economy. He admitted that the Fed was too optimistic about the economy and indicated that their outlook has changed. Throughout his press he said repeatedly the Fed is prepared to take further action, which is a strong signal that QE3 is in play. To drum this point in even further, Bernanke said the Fed still has ammunition, would consider further asset purchases and can provide additional support for the economy with an intention to do what they can. There’s no way to interpret this to mean anything outside of a growing intention to ease again which is negative for the U.S. dollar. It took investors a while to realize this, but by the end of the North American trading session, they did.

In terms of decisions made today, as we expected, the Fed extended Operation Twist. The program was suppose to end this month but will now run until the end of the year. The following table shows the changes to the Fed’s forecasts. The central bank downgraded its GDP and inflation outlook and upgraded its unemployment forecasts for 2012, 2013 and 2014. Twelve out of 19 FOMC participants expect the first rate hike from the Federal Reserve to come in 2014 or later. Although this is 2 more members than April, only 17 FOMC participants voted during that time due to vacancies. Nonetheless, this tells us that Federal Reserve Monetary Policy Committee as a whole (voting and nonvoting members) is very pessimistic about the outlook for the U.S. economy and as a result believe that monetary policy needs to be extremely easy until 2014. Another way to look at this is that most Fed officials do not expect a material recovery in the U.S. economy for the next 2 years. While it can be argued that Bernanke didn’t say anything new, we beg to differ – he admitted that the Fed was overly optimistic and his tone was are more negative than earlier this month. At the same time, Fed projections were downgraded across the board. With QE3 expectations renewed, we now expect near term weakness in the dollar, especially if there are positive headlines out of tomorrow’s EU Finance Ministers meeting and Friday’s four way summit between the leaders of the 4 largest countries in the Eurozone. Jobless claims, the Philadelphia Fed survey, existing home sales and leading indicators are due for release on Thursday. While important, these reports should not make the Federal Reserve any less dovish.

EUR: Thursday is a Big Day for Europe

While Europe’s sovereign debt crisis took a back seat to the Federal Reserve’s monetary policy announcement today, the focus will quickly shift back to the region over the next few hours as Thursday will be a busy day for Europe. Eurozone Finance Ministers will be meeting in Luxembourg to come up ways to end the crisis by strengthening the region’s fiscal and monetary union. According to the G20 statement, the leaders support the consideration of more concrete steps taken by European nations such as “a more integrated financial architecture, encompassing banking supervision, resolution and recapitalization, and deposit insurance.” The fact that EU leaders let these options be outlined in the G20 statement suggests that they have serious intentions to move forward with these measures. As a result, we expect the details to be discussed by finance ministers tomorrow. This will be followed by a four way meeting on Thursday between German Chancellor Merkel, French President Hollande, Italian Prime Minister Monti and Spanish Prime Minister Rajoy. All these meetings are in preparation for the EU Leaders Summit at the end of the month. The market is hoping that European policymakers are up to something big and for once, we believe that EU leaders will deliver. Spain and France will also hold bond auctions on Friday but Spain’s auction is small which means they should have no problem attracting investors. However there are two things that could threaten the EUR/USD rally – the results of Spanish government commissioned independent audits of local banks and the region’s PMI reports. Given the weakness of the ZEW survey, industrial production and factory orders reports, we expect manufacturing and service sector growth to slow in the Eurozone, which would increase the pressure on the European Central Bank to ease.

GBP: QE Coming in July

While the British pound ended the North American trading session slightly lower against the U.S. dollar, the currency should have experienced significantly steeper losses given this morning’s Bank of England minutes and labor market report. When the BoE last met earlier this month, they voted 5 to 4 to keep monetary policy unchanged. This means the central bank was one vote away from increasing asset purchases or Quantitative Easing this month. Going into the meeting, only Posen and Miles were expected to vote for more QE and if we were lucky, one additional member would switch camps. However both Paul Fisher AND BoE Governor Mervyn King joined Adam Posen and David Miles in voting for additional purchases. This tells us that the central bank is very close to easing again and could do so as quickly as next month. The primary reservation of the other 5 members who voted to keep policy unchanged is inflation – they were worried that inflation would quickly return back to target. Given that May saw the weakest inflation reading since November 2009, this concern is not a material one and if anything has become a weaker argument. The latest employment report also gives monetary policy committee members a stronger reason to pull the trigger on stimulus next month. The number of people filing for unemployment benefits increased 8.1k in May against expectations for a 4k decline. Job losses were the greatest since September 2011 but the 1.4 percent increase in average weekly earnings implies the labor market may not be as weak as the headline number suggests. Either way, the BoE is gearing up to ease and weaker labor market conditions will support their case in July. U.K. retail sales are due for release on Thursday and consumer spending is expected to rebound after a steep decline in April. If sales increase and sterling appreciates, we will look at it as an opportunity to sell at higher levels.

CAD: Looking for Increase in Retail Sales

The Australian and Canadian dollars ended the day virtually unchanged against the greenback while the New Zealand dollar lost value. After the release of the RBA minutes on Monday, the Aussie has been holding strong, particularly against the U.S. dollar. While traders have to adjust their positioning to account for a greater likelihood of QE from the Federal Reserve, they also have to now account for a lower chance of another rate cut from the RBA. In our opinion, the RBA could still ease again this year, particularly with leading indicators declining 1.4 percent in the month of April according to the Conference Board but for the time being, the central bank is in wait and see mode. Chinese flash manufacturing PMI numbers are due for release from HSBC tonight – a further contraction in activity could drag down the Australian dollar. New Zealand reported a smaller current account deficit in the first quarter but a larger current account to GDP ratio. First quarter growth figures are due for release this evening and while the country is expected to grow at a faster pace compared to the fourth quarter, on an annualized basis, growth is expected to slow. It will be a busy day for the Canadian dollar. Retail sales are due for release at 8:30 AM ET / 12:30 GMT followed by a speech from Bank of Canada Governor Carney at 11:45 ET / 15:45 GMT. Consumer spending is expected to slow in April but with employment rising strongly that month and wholesale sales ticking up by 1.5 percent, we are looking forward to an upside surprise.

JPY: TRADE DEFICIT CONTINUES TO GROW

The Japanese yen weakened against all the major currencies amid signs of progress in Europe. In a speech today Shirakawa said that Europe will be the biggest threat as Japan returns to the path of moderate recovery. Japan’s trade balance report released yesterday showed that there was a -907.3B yen deficit from the expected value of -544.4B. The trade deficit in the last 5 months already exceeded the entire deficit of last year. With the negative economic outlook, the Yen is suffering against the dollar. Foreign ownership in Japanese stocks and bonds and Japan’s ownership on foreign stocks and bonds will be released at 19:50 ET / 23:50 GMT. Foreign ownership of Japanese bonds was at a record high in 2011 while Japan households’ holdings fell the lowest since 2005 indicating Japan’s dependency on foreigner to finance their public debt. It will be interesting to see what June’s data is. On May there was a total of 494.2B yen invested by foreigners.

Kathy Lien
Managing Director

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